Medical Device Link.

Originally Published MX November/December 2005

COVER STORY

Interview by Steve Halasey

To become established in the medical device industry, it helps if a start-up company has a unique, exclusive technology at its core. But to thrive, the company must not only be able to capitalize on that technology, but also defend it.

Michael A. Baker, president and CEO of ArthroCare Corp. (Austin, TX), knows a little something about how to do both. Since taking the helm in 1997—the same year ArthroCare patented its fundamental technology, Coblation—Baker has seen to it that the company's investors receive every penny to which they're entitled. After all, it was their initial investments that funded the development of a process once considered impossible. And while ArthroCare has been leveraging that technology's applications in targeted medical fields, Coblation's potential has just begun to be tapped.

ArthroCare president and CEO Michael A. Baker on developing and defending a medtech innovation

ArthroCare has broad intellectual property protection on the process of Coblation. To date, it holds 107 U.S. and 45 international patents related to the technology, with numerous applications pending worldwide. The company's patent litigation history is something of a David and Goliath story, with a couple of twists. For one, it's a rare medtech David that is able to forecast annual revenues of more than $210 million. And for another, this medtech David has endured litigation involving three of industry's heaviest hitters—Ethicon (Somerville, NJ), a Johnson & Johnson company; Stryker Corp. (Kalamazoo, MI); and Smith & Nephew (London)—and emerged not only with still-valid patents, but also with new partners. Through licensing agreements, ArthroCare's investors now enjoy a slice of the pie from sales of Coblation-based devices by all three companies.

Under Baker's leadership, ArthroCare has developed more than just a good defensive strategy. The company has been growing steadily, expanding into new sectors organically and through carefully considered acquisitions. And, so far as Baker is concerned, ArthroCare is just getting started.

In this interview with MX editor-in-chief Steve Halasey, Baker discusses what it's like to uncover a never-before-seen technology and what a company has to do to fully leverage and protect it. He also describes ArthroCare's relationship with the clinical community, approach to acquisitions, and long-term game plan for growth.

MX: Tell me about the origins of Coblation technology and its intellectual property. Who developed it, where did it come from, and how did it come to ArthroCare?

Michael A. Baker: Coblation technology is the invention of the two gentlemen who founded ArthroCare, well-known medical device entrepreneurs Hira Thapliyal and Phil Eggers. These partners were working on a new generation of energy-based devices for cardiac applications to be used in a conductive fluid environment. Hira and Phil felt these devices would be highly applicable in many cardiac procedures because surgeons typically have to work in either a conductive environment or in a field of blood. What they discovered was a technology that had an effect very different from anything they had seen before. They saw tissue dissolving at a rapid and efficient rate with a high degree of precision, and they did not see the temperatures normally associated with electrocautery or radio-frequency devices.

Ultimately, Hira and Phil realized they were looking at a plasma phenomenon, which was interesting because, according to the body of physics understood at the time, it was not possible to create a stable plasma phenomenon at room temperature and atmospheric pressure.

How did that original discovery turn into today's company?

Hira and Phil originally founded the company as AngioCare, but later changed the name to ArthroCare because they were convinced, after consultations with their original venture capital investors, that the first and easiest application for Coblation technology would be in endoscopic surgery.

The first commercial sales occurred toward the end of 1995, and the company became public in 1996. The Coblation-based devices were a tremendous hit because they enabled arthroscopic surgeons to perform difficult and time-consuming procedures rapidly and with much greater ease than any preexisting mechanical or electrocautery tools.

How important is this new technology?

To give you a sense of just how fundamental that discovery was, a few years back we began talking to some scientists at Lawrence Berkeley National Laboratory, in California, who wanted to study our equipment. When they started their project, I think they believed they would discover that our marketing claims did not hold water. But after a few months, they came back to us and said, ‘You know, this is really something fundamentally new. You're really creating plasma, which is important because it has not been described adequately in the physics literature, and is really not known to science at this point.'

And from that starting point, ArthroCare now has three separate business units that it operates?

Yes. The largest and the oldest is the original sports medicine business unit, where we have established Coblation technology as the standard of care in a number of important areas. We believe the company is going to continue to establish Coblation technology in more sports medicine procedures as time goes by. The sports medicine market is a great market. Our business is growing rapidly as the population ages and people continue to be more active. There are more people out there who have orthopedic problems that they want fixed. As the technology and techniques improve, more of these fixes can be done endoscopically, which is tremendously beneficial because the patient can recover from endoscopic intervention much more rapidly and with much less pain.

Knee surgery was the first big market for Coblation in sports medicine. Shoulder surgeries were next, as the technology and techniques became better. And we are now seeing more and more doctors interested in doing surgery on smaller and more difficult joints, like hip, ankle, elbow, and wrist arthroscopy.

ArthroCare's other two business units are in ear, nose, and throat (ENT) medicine and spinal surgery. We are earlier in the development of those business units, but each has very exciting applications of Coblation technology.

Defending IP

When you roll out products for these business units, what is your strategy for defending the company's intellectual properties? Do all of your products rely on a central core of IP or do you protect the individual products going forward?

All of the above. ArthroCare probably has one of the strongest, broadest, and deepest intellectual property sets you are going to find around any technology, and it starts with the fact that Coblation technology was fundamentally new to science. We were able to get very broad fundamental patents around the science of creating and stabilizing a plasma at room temperature and atmospheric pressure, and then using it during surgery. ArthroCare then surrounded these patents with application patents for using the technology in various medical applications, and patents on individual products. Beyond all of those patents, there is a further wall of feature patents around the technical and design innovations that are important for making the technology work well in a given application.

We have licensed our patents more than a dozen times. And we have successfully enforced them in court three times. I think that track record over the last eight years pretty much speaks for itself.

You must be keeping a battery of lawyers busy to defend the company's IP portfolio. Do you have more than one outside IP firm or is most of your work done in-house?

We do have an in-house vice president of corporate development and legal affairs, John Raffle, who has been with the company for virtually my entire term as CEO. In our enforcement actions against Johnson & Johnson (J&J; New Brunswick, NJ), Stryker, and Smith & Nephew, we worked with Weil, Gotshal & Manges (New York City). Even with a very strong intellectual property set like the one we have, it is always nice to work with folks who have been down the path with you before and understand a lot of the ins and outs. I guess every time we have had to go through the litigation process, arguably we've gotten a little better at it.

Adversaries to Allies

The infringement case with Johnson & Johnson eventually turned into a licensing arrangement with Ethicon.

That is correct. Just before the trial was scheduled to start, we were able to agree on terms for a settlement and licensing agreement with them.

And you recently announced that you now have a new agreement with Smith & Nephew, which I assume is also a result of the litigation involving them.

Correct. Here's a quick history of our litigations: First, there was the Ethicon agreement. Then, a couple of years later, Stryker introduced a product set that we felt required a license. After a very brief enforcement action, we reached a settlement and licensing agreement with them.

In 2001, Smith & Nephew introduced a product set that we also felt required a license, and we initiated an enforcement action. That case came to trial in May 2003, and the jury found that they had, in fact, infringed our patents. About a year later, the judge handed down an injunction, which ordered their product set off the U.S. market. And now, about 15 months after the original injunction, we have announced a settlement agreement, and a license and product supply agreement that will allow Smith & Nephew to sell Coblation-based products not only in the United States, but also around the world.

You have three business units, but you have not entered certain areas yet. For instance, your licensing agreement with Ethicon permits that company to use the technology in gynecological applications. How comfortable do you feel about the decisions you have made to go after some areas and not others?

We feel very good. We just finished visiting this question at our annual off-site strategic planning meeting. We granted Ethicon a nonexclusive license to use Coblation technology in gynecology, and they have had some degree of success there. However, there may be applications in gynecology even beyond what Ethicon is currently doing. There is nothing in the Ethicon agreement that would prevent us from either licensing our technology to somebody else or going into those applications on our own. The same is true for urology.

Harvesting Clinical Feedback

How are you developing these new ideas? Are doctors coming to you with ideas for Coblation applications in other fields or is ArthroCare being active in searching out those opportunities?

A little of both. Physicians will come to us with ideas about Coblation applications for other parts of the body, and those are great discussions. We have ended up developing new products as a result, such as the tonsillectomy product that is currently driving the rapid growth in our ENT business. In our original thinking about ENT, tonsillectomy was not a compelling part of that opportunity. But, as we became involved in the field and began talking to doctors, they pointed out that there was an enormous opportunity to improve a very common operation that had seen no significant advance in decades. We worked with them to develop what ultimately has become an extremely successful tonsillectomy product.

Listening carefully and using the opportunity to work with surgeons can help a company develop a technology and become a leader in the field. That's even before you begin adding complementary products to your business. We have seen this type of situation happen in sports medicine, and I am optimistic we are beginning to see the same happening in ENT.

Is the company's spine business a little further off in that regard?

The spine business is currently our smallest and slowest-growing business. But when you look at the potential opportunities and the technologies and applications that are in the pipeline, it would not surprise me in the least to look back in three to five years and see the spine business as the biggest and most profitable unit in the company. The opportunities in this market are potentially very large and lucrative.

Complementary Acquisitions

How do ArthroCare's recent acquisitions complement the company's existing technology and business units?

ArthroCare is emphatically an organic growth company. Even without any of our acquisitions, this company would be a rapid-revenue-growth company, profitable, and cash-flow positive.

The acquisitions contribute to the strategy of the various business units. When we start a business unit, we are using a set of Coblation instruments to establish a beachhead in an area of medicine. When we make an acquisition, we know it will complement and be compatible with our Coblation applications.

We have had a remarkable acquisition track record so far. Each acquisition has met or exceeded our expectations, and part of that may be because we really do pursue acquisitions as an exception strategy.

It has been almost a year since the Opus acquisition. How did the integration of that company go?

The integration of Opus went wonderfully. Not only is the Opus product set tracking ahead of its guidance, but our core Coblation product set also is tracking ahead of its guidance. When you make an acquisition, you always hope you are going to see that kind of strong cross-selling synergy, and I am happy to say, in this case, it is very obvious we are seeing it.

Site Selection

I understand that you moved all of your manufacturing to plants in Costa Rica. How did you end up manufacturing there as opposed to someplace else offshore, nearshore, or in the United States?

At the time we began studying that initiative, we had 100% of our operations in Silicon Valley, which is a very expensive place to operate. It was obvious that at the rate ArthroCare was growing, we needed a higher-volume manufacturing facility. We looked at sites in Europe, the United States, Latin America, and Asia. Coincidentally, the government of Costa Rica had recently decided it was interested in attracting medical device manufacturers.

What benefits does Costa Rica offer manufacturers?

It had a very strong package of incentives, which included a tax deal that would allow us to shelter our manufacturing profits from Costa Rican taxes for the first 10 years and then pay a relatively low corporate tax after that. When we visited Costa Rica, we also found a high-quality workforce, operating in a very safe and democratic environment.

ArthroCare occupies a very rare niche in the medical device industry—that group of companies with revenues of more than $100 million but less than $500 million. Such companies usually tend to get snapped up by one of the larger companies. Do you think ArthroCare will remain an independent, publicly owned company, or is the company potentially an acquisition target for a larger company?

There are not very many medtech companies of our size—and even fewer of our size and growth rate—that are currently operating as independent companies.

The great thing is that we are growing rapidly, we are profitable and cash-flow positive, and we are expanding our profit and cash-flow margins as we go. We've built a platform we can leverage as we go forward, which means that we do not have to sell the company. We control our own fate. We are going to be a much larger company a year from now and an even larger company a year after that. If we would be a positive and meaningful acquisition for a larger company today, we would be an even more positive and meaningful acquisition a year from now.

So, we are in a position that I like a lot, which is that we are building shareholder value rapidly, and we have the opportunity to continue doing so as an independent company for the foreseeable future.

Copyright ©2005 MX